The key focus of the central bank on the liquidity front over the last year has been to ensure that the government’s borrowing program goes through without causing disruption.
The Monetary Policy Committee (MPC) expectedly kept the key rates unchanged and reiterated its ‘accommodative’ stance both on rates and liquidity. However, considering the new evolving uncertainties on account of the second wave of COVID-19, the guidance has become more open-ended as the MPC committed to maintaining an ‘accommodative’ monetary policy as long as necessary to sustain growth on a durable basis and continue to mitigate the impact of COVID-19 on the economy. The second COVID-19 wave is impacting many regions in the country and has resulted in localised lockdowns and curfew in key states. This poses a growth risk. Hence, the re-iteration of the ‘accommodative’ stance has provided comfort to the debt and money markets.
On the macro parameters, the inflation forecast for the first half of FY22 has been raised very mildly, at 5.2 percent in Q1-Q2 of FY22, 4.4 percent in Q3, and 5.1 percent in Q4, with risks broadly balanced: strong food production output and to be countered by possible cost-push pressures. The MPC expects GDP growth to clock 10.5 percent in FY22. Rural demand remains resilient and record agriculture production for 2020-21 proves well for its resilience in the near future. Urban demand has been gaining pace due to the normalisation of economic activity and should get a further boost with the ongoing vaccination drive.
The key focus of the central bank on the liquidity front over the last year has been to ensure that the government’s borrowing program goes through without causing disruption. In the policy, the RBI surprised the markets by announcing a new program – Government Security Acquisition Programme (G-SAP 1.0) – under which it has committed to buy Rs 1 lakh crore of G-Sec.
Under this program, it is committing to ostensibly provide more comfort to the bond market in light of the government’s elevated borrowing for this year. This is the first time, in recent times, that RBI has committed to buy an amount from the secondary market. The first open market operations (OMO) of Rs 25,000 crore has been announced for April 15, 2021. RBI further acknowledged that liquidity in the system was high and hence they are likely to do more longer-term variable reverse repo rate (VRRR) auctions.
There is a change in stance from a ‘calendarized approach to monetary policy tightening’ to ‘accommodative till growth returns’ at an aggregate level factors like supply concerns in FY22 on account of expansionary Budget and rising commodity prices are likely to keep any market optimism in check for the bond markets. While the markets rallied today post the OMO news, with the longer-end rallying more as news of VRRR impacted sentiment on the short end. The curve may flatten from here as RBI is cautious on excess liquidity in the system and may try to sterilise it through normal liquidity operations like VRRR. However, the long-end may not rally too much on large government supply. Going forward, the markets will likely look towards incoming data like CPI inflation as well demand in government auctions starting this week. Global cues like the US rate movement, oil price, etc. will continue to drive the sentiment.
The windfall capital gains of CY19 and CY20 are behind us, and fixed-income investors need to tread cautiously in CY21. We reiterate our views that investors need to brace for ensuing volatility in 2021 and calibrate their return expectations accordingly, as well as elongate their investment horizon to weather the intermittent volatility. To navigate volatility/uncertainty, investors need to diversify within their fixed income portfolios through a combination of liquidity (repricing opportunity in a rising rate scenario), accrual/carry (yield enhancement through quality short duration non-AAA), and active duration (managing volatility).
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Rupen Rajguru is the Head of Equity Investment and Strategy at Julius Baer.
